When you visit a grocery store, you want to find what’s on your list and hopefully get it at a good price. If you’re strolling down the aisles and you come across empty shelves or damaged and expired goods, it’s safe to say you won’t be a satisfied customer.

Stanley Lim headshot

Stanley Lim, assistant professor of supply chain management

Retailers work to avoid this inventory problem by managing replenishment and entering contracts with their many suppliers. These contracts assign different responsibilities, risks and losses to each party. New research from Michigan State University, Arizona State University and California State University is the first to reveal how scan-based trading, a specific type of contractual relationship, can benefit both retailers and suppliers, increase profit throughout the supply chain and improve bargaining dynamics for both sides.

“Scan-based trading, or SBT, started sometime in the early 2000s, but despite the many benefits offered to retailers and their suppliers, it has not gained as much traction compared to traditional agreements,” Stanley Lim, assistant professor of supply chain management, said. “Although anecdotal evidence and industry reports tend to suggest the emergence of SBT as a manifestation of retailers’ bargaining power or dominant market positions over suppliers, with no significant benefit to the latter, we find that both parties can actually benefit from entering into an SBT arrangement.”

The research paper, “Scan-Based Trading and Bargaining Equilibrium: A Structural Estimation of Supply Chain Profit,” was published in March by Manufacturing & Service Operations Management — one of the top-tier journals in the supply chain field. Lim was the lead author for the paper, working with coauthors Timothy Richards, Morrison Chair of Agribusiness at Arizona State, Elliot Rabinovich, AVNET professor of supply chain management at Arizona State, and Min Choi, assistant professor of management at California State.

They explain that under SBT agreements, suppliers take on ownership of inventory, incurring related labor costs and any product- or execution-related losses, known in the industry as shrink. Although this seems instantly attractive for retailers who don’t bear these costs or own the risks, suppliers also gain real-time demand information from retailers, which can improve their forecasting, decrease lead times and boost sales.

“Companies typically want to enter into a win-win contract arrangement, rather than one that is a loss to a party and a gain for the other,” Lim said. “So, even if a specific type of contract arrangement can represent efficiency gain from a system standpoint or leads to better customer service/experience, if it doesn’t translate into profits after accounting for the costs, then parties would typically be wary to enter into these arrangements and choose to remain status quo.”

Together, the researchers reviewed months of inventory data for an industry with nearly $40 billion in annual revenue: baked goods. Muffins, bread, cookies, bagels and other baked goods have a short shelf life and ongoing, continuous demand, which means rapid replenishment cycles and lots of data.

They studied a number of national bakery suppliers and competing regional retail chains in the United States, finding that the average number of deliveries per week and average number of baked goods sold per week were significantly higher for those operating under SBT. Further, average wholesale prices were also higher under SBT, which equated to a 25% average increase in profits across the supply chain.

“Although the suppliers are liable for all the shrink costs, they benefit from a better bargaining position and are able to negotiate higher wholesale prices on average,” Lim said. “As such, their share of profit increases.

“On the retailer side, they maintain higher bargaining power — as suppliers seek to tap into their brand share, market coverage and sales volume — and they benefit from higher profits, but their slice of the pie decreases since they don’t take on any financial risks from carrying inventory and their management and labor costs are decreased.”

On the whole, the team found that SBT may be more attractive to smaller retailers. According to Lim, these retailers may be faced with limited resources, or if they’re seeking growth and don’t want their capital tied up in inventory, they’ll defer these responsibilities to the supplier.

“We shed light on the role of shrink, which conventionally has been viewed as an inhibitor of the adoption of SBT contracts,” Lim said. “In addition to wholesale prices, which are typically the main instrument for negotiation during the contracting process, managers should include and carefully discuss the allocation of shrink costs among parties and pay attention to accurately estimating the amount of operational shrink loss, particularly for the suppliers. This way, negotiated terms in the contract are more likely to benefit both parties.”